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As population ages, Menlo Park incubator invests in new medical devices

By Joe Ciolli | 4 May 2011

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The Foundry in Menlo Park is an incubator specializing in medical device startups. (Photo: Joe Ciolli)

Experts speculate that the medical device industry is entering a golden age. After all, as age-related chronic diseases continue to affect individuals, the baby boomer generation is requiring increased levels of medical attention.

But even as the rate of disease climbs at many times the rate of population growth, some existing medical device companies appear equipped to meet increased demand.

For example, firms such as the Foundry, a Menlo Park device incubator, have been around for over a decade, laying the groundwork for a new generation of biotech firms poised to tackle the baby boomers’ growing needs.

Since launching in 1998, the firm has founded and financed over 12 medical device companies, including Ardian, Inc., Evalve, Inc. and Concentric Medical, Inc. These businesses, which develop everything from hypertension therapies to cardiac valves to interventions for stroke, have generated in excess of $1.5 billion in value for their founders and investors and employ more than 350 people. The Foundry helps provide each company with a financial foundation and aids each entity with business and product development, market analysis, intellectual property and recruitment.

The Foundry has sold two of its portfolio companies in the last several years. Most recently, in January 2011, Medtronic Inc. completed a $800 million acquisition of Ardian. In addition, in October 2007, the Foundry’s ForSight Vision2 was purchased by QLT Inc. for $42 million plus milestone payments.

Cary Reich, Ph.D., the chief technology officer at ForSight Labs, an ophthalmic incubator created in 2005 by the Foundry, said, “They provide the space, initial funding and management support that these companies need. Although probably the biggest thing that they do is hire and staff the companies.”

Slower pace; predictable returns

In the late 90’s, while many dot-com startups carried the risk profile of junk bonds, device firms operated more like treasury securities: earning modest yet consistent returns, thereby rewarding patience.

The Foundry’s president and chief executive officer, Hanson Gifford, views the device sector as a model of consistency. “In general, the medical device industry is considered to give more predictable returns,” Gifford said. “Although they’re usually somewhat more modest.”

Gifford attributes the slow-paced nature of the medical device industry to the clinical trial process. “The medical device industry is constantly fighting to be more efficient,” he said. “However, it’s almost impossible to speed the clinical trial process and its very significant follow-up.”

Despite the deliberate nature of product development, medical device companies still have to adjust to changing market conditions and competitive landscapes. For the Foundry, this adaptability has been key to identifying and obtaining funding opportunities.

In a recent panel discussion during Stanford University’s Entrepreneurship Week, Foundry chairman Allan Will outlined the three-part evolution of the firm’s financing model. When it first started, the firm received 90 percent of its seed funding from serial entrepreneurs, while the other 10 percent came from venture capitalists.

“That worked fine,” Will said. “But at the end of the project we found ourselves pitching hard to get the venture funding. We then evolved to a second model where we allowed venture funds to have more skin in the game right from the start.”

The Foundry now partners on seed funding with Morgenthaler Ventures and Split Rock Partners, where Will serves as a managing partner. The Foundry normally orchestrates investments of between $10 million and $12 million. In addition, the venture capital arms of major corporations have emerged as a reliable financing source for strategic investments. Gifford noted that nearly all major healthcare firms now have some sort of investment branch.

“We are seeing more corporate investment,” Gifford said. “We’re always thinking about how to structure things even more efficiently, and I think we’ll be seeing more creative partnering efforts between early medical device companies and strategic partners in the future.

Increased FDA scrutiny

And in a time of growing demand for medical devices, increased funding will also be needed, allowing standalone venture capitalists to coexist with the strategic venture arms of corporations.

Meanwhile, as initial public offering activity has picked up across all sectors medical device firms — including the Foundry — have been hesitant to test the capital markets. Avondale Partners analyst Dan Owczarski attributed this to an increasingly stringent clinical testing environment. Owczarski noted that following Medtronic Inc.’s 2009 pacemaker recall, the U.S. Food and Drug Administration clamped down on medical device development.

“Lately IPOs have really slowed down with the uncertainty surrounding the regulatory environment,” Owczarski said. “People are incredibly frustrated with the FDA process, and some small private companies don’t even understand what the FDA wants.”

Reich added that the FDA’s increased scrutiny “makes the capital markets much more skittish and concerned” and noted that “because of the uncertainty, risks are much higher.”

Gifford believes that making the jump to a public company makes sense for those with a certain critical mass. He said that these companies have to already be profitable and can’t be valued on the potential of specific technologies. Gifford notes that his firm’s portfolio companies rarely reach this point while still under Foundry control, a period that can last up to 10 years.

“There is, for all companies, an urgency to make things happen, including reaching some sort of validation of value or a liquidity event,” Gifford said. “But sometimes the greatest value creation happens after a company has already reached the profitability and is still growing rapidly.”

Gifford was also quick to point out that developing new medical devices can reap returns that have nothing to do with the bottom line. To him, helping patients suffering from diseases and creating fulfilling jobs for people is the ultimate reward. That, and what Gifford described as the “self-actualization of inventing new ideas.”

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